When I was much younger, a seasoned real estate professional explained the nature of rental pricing. It has to do only with the margin. The few things actually in play. The large underlying base has little effect in the short term.

“If there is one store vacant downtown and no likely tenant, there is a glut and prices will fall. If there is one person looking for space and no empty store, then there is a shortage and prices will rise. The hundreds of stores that are filled and intend to remain that way have no immediate effect.”

Apply that to the oil market.

According to the US energy information administration, total global demand for oil projected for 2015 is 92.39 million barrels per day. Supply is 92.97 million barrels. Therefore a glut. Prices fall and many are helped and some are harmed.

But the glut is just 0.6% of the supply. Prices have fallen much more sharply than that might suggest and it could easily be eliminated if the producers wished to do so. There may be reasons they have not done so.

Notice that according to consulting firm PFC Energy, 65% of oil and gas reserves are state-owned and another 28% are in countries that have strong rules regarding their reserves. Could it be that oil prices are more political than market driven?

Another important factor is that businesses tend to base prices on the variable cost of production. In the oil business, these costs are greatly less than the world price. Even in the Canadian oil sands, a difficult operating environment, variable costs are barely over $10 per barrel. In the Arabian gulf they are a tiny fraction of that. Clearly cost to deliver is not a material factor for existing facilities.

Governments do not act like businesses. They have other needs for the money. Their breakeven price for oil given their budgetary needs, could be much higher than the current price. Russia, Iran and Venezuela for example need much more to meet budgetary and financial obligations. Governments who have lower needs can manipulate those with higher needs by changing their production levels.

Could it be that there is little love between Saudi Arabia and Iran? An economic attack is still an attack and the Saudis may prefer to destroy Iran financially before Iran can launch atomic weapons their way.

Oil pricing is no longer a rational subject for analysis. It does make for great drama though.

Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. Contact: don@moneyfyi.com

One Response to Oil Prices Are Political Not Economic

Who understands what’s going on with oil prices? If it gets more expensive then gasoline gets double expensive, but if it becomes cheaper like nowadays then it takes pretty long for gasoline to start decreasing its price…